Labour counting on Brown's clout

There was a time during the Trojan war when things were going badly for the Greeks. Achilles had got the hump and was sulking in his tent; while he was out of action, the emboldened Trojans were threatening to drive the Greeks back into the sea.

In the nick of time, Achilles re-entered the fray. He donned his gleaming golden armour and rode out on to the battlefield, where his very presence was enough to raise the flagging spirits of the Greeks and strike terror into the hearts of the Trojans. He then proceeded to slaughter everybody in sight.

Labour MPs are banking on Gordon Brown doing for them what Achilles did for the Greeks. While the chancellor has been away from the battlefield preparing his budget, the government has been having a thoroughly rotten time of it, culminating in last week's decision by BMW to give up on Longbridge. There is a sullen mood out in the heartlands, while for the first time since their trouncing almost three years ago the Conservatives have rediscovered some of their old swagger.

Brown has not exactly been sulking in his tent, but his low profile since the turn of the year has meant that not only has he escaped any blame for the government's current woes but is seen as the only man who can turn the tide back in the government's favour. If the chancellor can put the Tories to flight tomorrow and garner the right sort of headlines in Wednesday's papers, Labour MPs will forget that Brown has been responsible for the government's perceived failures - the cash crisis in the NHS, for example - as well as its successes.

Hard cash

And, on the face of it, the chancellor has everything in his favour. The economy did better than expected last year, allowing the treasury to build up a hefty fiscal surplus. There is money in the bank - so much money that Brown is able to do what Nigel Lawson did in the late 80s - cut taxes, raise spending and pay off debt all at the same time. Given the current gloom and despondency in Labour's ranks, it would be the simplest thing in the world for the chancellor to hand out a few lollipops tomorrow, but the budget is likely to be a bit more complex than that.

Brown's first consideration is the need to dovetail fiscal policy with monetary policy. In theory, he could blow the entire surplus on tax cuts or higher spending, but the Bank of England would almost certainly respond by banging up interest rates to compensate for the boost to demand. At a time when there is justifiable concern about the strength of the pound, this would not be the wisest course of action and, in terms of macro-economic management, there is a case for even tougher fiscal policy so that monetary policy takes less of the strain in holding inflation to the government's 2.5% target.

However, tightening fiscal policy is tricky when the government is already running a whopping surplus, the voters are spitting blood about the state of schools and hospitals, and the Conservatives are banging on day after day about how the tax burden has increased under Labour.

So how does the treasury cope with this dilemma? The macro-economic assumption will be that the effects of higher interest rates and the strong pound will start to slow the economy down during the course of this year, making a modest relaxation of fiscal policy acceptable. However, this will probably be limited to the minimum necessary to prevent the tax burden from rising due to the effects of fiscal drag, whereby people pay more to the inland revenue as their incomes rise. In hard cash, this means that Brown would have to cut taxes by around £2bn to keep the tax burden where it is, £3bn to reduce it.

If anything, the willingness of Downing Street to admit for the first time last week that the tax burden has gone up under Labour suggests that it might be the higher of the two figures, and that the Conservatives are being lured on to a sucker punch.

Missing link

All the indications are that the beneficiaries of the chancellor's largesse will be those he considers the deserving rich and the deserving poor. The budget's theme is the need to raise Britain's economic performance to close the productivity gap with Germany, France and the United States, so there will be tax breaks on share options for the new breed of entrepreneurs starting up their own companies, together with tax credits for spending on research and development. At the other end of the scale, Brown is likely to increase the generosity of the working families tax credit and levy the 10p starting rate of tax on a higher slice of taxable income.

Some of the other likely measures have already been well trailed. There will be measures designed to bring a halt to the housing boom in the south, while the rise in global oil prices means that the policy of increasing petrol duties by well in excess of inflation has been junked.

But there is still something missing. Brown loves to plan for the long term, but as the prime minister has no doubt reminded his chancellor, the long term is a series of short terms. And in the short term, the government is in trouble and needs a political boost from the budget. So what is it to be? Another cut in the basic rate of income tax? A reduction in duties on booze and fags? Or something else?

Squaring circles

Let us look at it from the government's point of view. Despite all the recent fuss, there has been quite substantial redistribution over the past three years but in two key areas it is felt that Labour has not delivered. The first is the provision of public services - particularly health and education. The second is pensions.

On spending, Labour's parsimony in its first two years has now come back to haunt it. Budgets for health and education are now increasing by 5% in real terms, but it will take time to make good the effects of the earlier freeze, let alone deliver the improvements the electorate thought it was voting for in 1997. Up until now, the strategy has been to announce a new three-year spending deal in the summer, promising at least the same inflation-busting deal for health and education until well into the next parliament. That would allow Alan Milburn and David Blunkett to hand out all sorts of goodies during the autumn, softening up voters for an election next spring.

Brown may now be forced to rethink the timing of this approach. Assumptions have to be made in the budget about spending, and the chancellor could make a virtue of necessity by announcing that public spending can rise by at least as much in the second three-year spending round as it did in the first, with the government again focussing on its priorities of health and education. Specific commitments for individual departments look less likely at this stage because the treasury wants to ensure, particularly in health, that extra cash is accompanied by reform.

One group that has not featured in the pre-budget speculation has been pensioners, which is strange given that pensioners are well organised, vociferous and extremely unhappy with the government. Rather than restore the link between the universal state pension and earnings, Brown has plumped for a means-testing approach, arguing that he wants to focus support on the poorest pensioners.

Squaring this circle is not going to be easy. Unless the chancellor is prepared to abandon his whole approach to the welfare state, he is not going to announce a big increase in the state pension. But he is a strong believer in tax credits, and there is nothing to stop him extending the principle to pensioners, many of whom pay tax on savings. A properly tapered pensioners tax credit would allow those on modest income to escape tax altogether without applying to wealthy pensioners.

While this will not go far enough for pensioners groups, my guess is that the chancellor will once again be the darling of Labour MPs come tomorrow night. Whether the budget is a long-term solution to the government's travails remains to be seen. Achilles, it should be remembered, did not win the Trojan war, he merely saved the Greeks from defeat. In the end, he had a weak spot. So, too, does Mr Brown: the strength of the pound.